"If the renter had perfect foresight between 1988 and 2017, they would have put 47 per cent of their money into government bonds, 17.1 per cent into a single investment property, 14.6 per cent into high yield bonds, 13.5 per cent into cash, and just 7.5 per cent into local equities with no allocation at all to global shares. Doing so gives them a 7 per cent annual return with the lowest possible risk. One noteworthy result is the modest equity weight selected by the unconstrained investor, which pales in comparison to most super funds. (You get similar results if you use Aussie data.) The typical industry or retail super fund piles more than 75 per cent of their default portfolio into local shares, global equities, private equity, property equity, infrastructure equity and hedge fund equities. That is to say, they are taking on far too much equity risk for their inflation plus 4 per cent return targets, which over the last 10 years most have failed to hit precisely because of their equity drawdowns. Also note the nuance that the residential property allocation is actually to a single family home, not the overall housing market. To make the exercise realistic we scaled up the volatility of the national house price index several times to approximate the riskiness of an individual home, which is consistent with recommendations in the empirical research literature. The home owner makes very different decisions. With half their wealth locked-up in an individual property, the optimal portfolio choice is to allocate 23.4 per cent to government bonds, 15.8 per cent to cash, 8.9 per cent to high-yield debt, 1.9 per cent to global shares and an even smaller 0.3 per cent in gold. Observe that local equities play no role at all. Proportionately, this investor has huge amounts of housing risk, so they significantly reduce their exposure to similarly volatile shares, replacing it with more defensive fixed-income that sits further up the capital structure. This is interesting because around half of all super fund members own their home with the other half renting. They therefore require radically different solutions. If trustees took the time to recognise this fact, they might consider offering members "home owner" and "renter" options that account for their disparate wealth positions. In the case of home owners, the fact they are leveraged into idiosyncratic housing equity means they have an inherent appetite for more defensive (and uncorrelated) assets. In contrast, renters will have very different portfolio preferences. Of course, folks sometimes switch from one cohort to the other. At that juncture, they could also change their super fund options. To the best of my knowledge, no super fund yet offers these alternatives, which would presumably be very powerful from a marketing perspective. This idea is, however, related to, and a significant extension of, the notion of "life-cycle investing", which sensibly advocates adjusting the idealised portfolio composition according to a client's age and income needs." Read full article at AFR here.

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Jordan Eliseo
Aug 18, 2017

Interesting and thought provoking read Chris......i'd think a lots of the newer entrants to the super space could do this easier as they won't have the legacy tech issues.....definitely something to watch

Graeme Holbeach
Aug 20, 2017

Interesting concept that is worth further exploration. However it wasn't mentioned in the article that the performance of markets from 1988 to now was probably a once in a life-time bond bull market (10 yr Aust Govt bonds were 13%, now <3%). Of course I realise that it was used to demonstrate a principle, but it also highlights that the success of any asset allocation plan will only be known in the future. In 30 years time, one may look back and conclude that it would have been best to completely ignore one's housing situation!

ken dorge
Aug 28, 2017

a great perspective which my industry super fund cannot get its head around. most super funds I used have even more limited grasp of effective reporting in that the data they give members is so untimely and useless for decision making independently of their untransparent poor client info systems (my account cannot be usefully analysed without laborious self generated spreadsheets. They can't even give me that.)